What to Watch in Crypto

No sector moves at the pace of crypto. Nor does any other space match its volatility. Projects that seem invulnerable one month are beaten down the next. Technologies that appear underbaked one moment can suddenly flourish. 

Because of these dynamics, predicting the sector’s progress is tricky, requiring significant knowledge, immaculate timing, and no little boldness. Last year, The Generalist kicked off a series designed to give our readers a headstart in spotting the path ahead. “What to Watch in Crypto” asks some of the sharpest investors in the world what they think is worth keeping an eye on over the next six months. Previous contributors highlighted Solana, Ceramic, THORchain, Uniswap, Helium, and others before meaningful momentum. They also shared provocative thoughts on wallets, collateralizing NFTs, and crypto’s multi-chain future. 

It is an apposite time for our third edition. In a month, Ethereum is expected to transition to a more energy-efficient “proof of stake” consensus mechanism – an event referred to as “the merge.” If successful, it will represent a meaningful and impactful moment in crypto’s history. Already, positive advance tests have breathed life into the downtrodden markets, improving the price of ether by 66% over the last thirty days. Further down the food chain, entrepreneurial interest in crypto continues, with new projects attracting talent and funding. 

Perhaps because of those dynamics, I think today’s entry is our best. It features fifteen ideas from many of the sector’s most thoughtful voices spanning social media, lending, privacy, NFTs, and beyond. If you’d like to read our earlier editions, you can find Part 1 and Part 2 here. 

Trend: Regenerative Finance 

Web3 gives us powerful new tools to coordinate economic activity. One of the most important problems we can target with this new power is the climate crisis.

Toucan Protocol is one of the founding projects in the so-called Regenerative Finance (ReFi) space, which aims to harness the power of crypto and DeFi to finance environmentally restorative efforts. (USV is an investor in Toucan's DAO.) The first area where Toucan and other ReFi projects have focused is bringing carbon credits on-chain. This simple first step unlocks new use cases, such as using carbon as collateral in DeFi protocols and representing carbon sequestration as NFTs and in the metaverse. 

The composable nature of tokenized natural assets means that climate action can be embedded into other protocols and applications. This can unlock more use cases and channels of demand. Looking ahead, new sources of on-chain demand for carbon tokens can help support a robust financing ecosystem for environmental project development in the real world.

It’s a pivotal moment for the ReFi movement. Ethereum’s impending switch from proof-of-work to proof-of-stake — and its resulting ~99% drop in energy consumption — has the potential to vastly broaden the appeal of crypto and web3 to mainstream audiences. At the same time, web3 infrastructure has matured to the point where it can better onboard more mainstream users. Toucan and the ReFi movement are poised to take advantage of the moment.

-  Nick Grossman, General Partner at Union Square Ventures

Farcaster

Social and crypto has been attempted since 2013, but no one has stuck the landing. We think that’s about to change. Why now?

One reason is that crypto wallet penetration has tipped in user quantity and usage quality. Millions of individuals not only have crypto wallets but use them frequently and for various purposes. For the first time, crypto wallets are a viable form of identity and method of sign-on for social products. On top of that, each wallet brings an on-chain “event feed” with it that can serve as conversation fodder (or, as we suits call it, “an engagement hook”) within a social network. For example, your participation in an NFT mint could appear on your feed. 

Another important reason crypto-powered social can work is the path dependence of user growth within a social network. Social networks that win start with the right early-adopter cohort. Think of good early adopters as time travelers from the future who instinctively behave in a way that the masses of tomorrow will. A social network that attracts and engages the right early user cohort is well on its way to success. We think the crypto community is as compelling an early adopter segment as we’ve encountered. Crypto-powered social networks, naturally, have an advantage in cultivating this native community.

Building a crypto social network is entrepreneurship on the “expert” difficulty setting. It requires a great product, a thoughtful underlying protocol, and a knack for community building. We believe Farcaster shows all the early signs of getting it right. To join, message founder Dan Romero on Twitter for an invite.

- Alok Vasudev, co-founder and partner at Standard Crypto

Notifi

In the web2 space, users sign up with their email and password when they want to create a new account. This acts as the default communication channel for applications. This is not the case in web3. Since authentication and sign-in happen with wallet addresses, there are no natural methods for developers to communicate with their users. As a result, many “user notifications” occur via Discord or Telegram, where they’re unspecific and untargeted.

Founded by Paul Kim and Nimesh Amin, Notifi is building Twilio for web3, starting with decentralized application (dApp) developers on the Solana, NEAR, Ethereum, Aptos, and Sui ecosystems. Notifi offers a simple embeddable notification layer for developers to plug into their existing DeFi, NFT, gaming, or DAO applications to communicate with users. Here are just a few use cases that Paul and Nimesh are addressing:

• Notifications on new governance votes
• Notifications on results of governance actions
• Notifications about bids on marketplaces
• Notifications of liquidations
• Notifications of incoming and outgoing transactions

These notifications can occur via email, text, or Telegram, with many more channels to come. 

- Edith Yeung, General Partner at Race Capital

Portabl

When it comes to authentication, we live between web2 and web3 worlds. The painstaking credentialing required to access your bank account doesn’t carry over to your web3 wallet. We believe this sub-optimal state of affairs will change with regulatory, consumer, and business tailwinds driving a shift toward self-sovereign identity. For example, earlier this year, eight U.S. states announced they supported digital storage of driver’s licenses, with Apple’s Wallet app acting as the authorized agent on the back end. 

These shifts hint at a compelling, emerging future where users own their data, control what data is shared, and seamlessly move between web2 and web3. 

The 6MV team is excited by one of our recent investments, Portabl, which solves for self-sovereign identity and authentication. The company creates a universal digital identity that enables consumers to selectively disclose their verified financial identity anywhere they need across web2 and web3​​ — keeping their privacy and security intact. In exchange, providers reduce onboarding to two clicks and automate away 75% of maintenance, monitoring, and audit costs. 

A consumer-first financial identity should be persistent, transferrable, and portable. Modern open finance can only succeed if we shake off the one-to-one relationship between accounts and verifications. For a peek at Portabl’s roadmap and what it enables, check out their upcoming B2B offerings.

- Mike Dudas and Michelle Dhansinghani, investors at 6MV

Axelar

As recently as 2020, Bitcoin and Ethereum were the only blockchains with meaningful adoption. Over the past two years, however, blockspace on those two chains has filled up, and we’ve rapidly entered a multi-chain world, with the growth of higher throughput Layer 1s (L1s) such as Solana, Flow, and Avalanche. We believe this explosion in complexity is just beginning and that the blockchain ecosystem will evolve over the long term into a vibrant network of networks, with a handful of critical generalized chains and hundreds or thousands of app-specific chains. The key to unlocking this potential is the concept of interoperability — the idea that otherwise distinct computer networks can communicate and work together. In an interoperable crypto world, developers will be able to build applications and experiences that are natively multi-chain. At the same time, users will be able to move assets and pass data across chains seamlessly.

Cosmos is perhaps the standard bearer for interoperability. Founded in 2017, the “internet of blockchains” is sometimes characterized as a competitor to Ethereum, but the two are conceptually quite different. Whereas Ethereum is a single monolithic blockchain whose apps are built on native smart contracts, Cosmos is a framework for launching new blockchains using the Cosmos SDK. Cosmos chains use a proof-of-stake consensus algorithm called Tendermint and can be connected using a bridging protocol called the Inter-Blockchain Communication protocol (IBC). Cosmos Hub, the first Tendermint-based blockchain, sits at the center of this network and provides services to other blockchains that are part of the “interchain” — the extended network of blockchains that interact with Cosmos. This includes asset routing and interchain staking.

The Cosmos vision is inherently more decentralized and perhaps more resilient than monolithic L1s. It fared pretty well after Terra, the biggest Cosmos chain, imploded. (There are tradeoffs concerning the composability of applications.) Furthermore, its architecture allows companies to launch chains customized for their specific use cases or build chains that can provide services across the ecosystem. Over the long term, it can integrate with the broader ecosystem of L1s, including Ethereum. And despite being less hyped than other heavily marketed chains, Cosmos has strong grassroots momentum. We are seeing great technical talent building the next wave of infrastructure in the Cosmos ecosystem, including North Island Ventures’ (NIV) portfolio companies Polymer, Lava, and Stride, which we consider a leading indicator. Furthermore, we’re starting to see the launch of major app chains, with dYdX being the most prominent to announce its move from Ethereum to Cosmos.

Meanwhile, new protocols such as Axelar are also making substantial progress in enabling greater interoperability. Axelar is a Layer 1 whose primary purpose is to transfer assets across chains and enable developers to build multi-chain dApps. An early example is AxelarSea, a cross-chain NFT marketplace. Recent bridge hacks have led to widespread and justified skepticism that a cross-chain world will ever come to fruition (even Vitalik believes the future is multi-chain, but not cross-chain). However, we believe these hacks are primarily because most bridges deployed to date have been highly centralized or rushed to market. Axelar is not a centralized point-to-point bridge but a full-scale proof-of-stake network built by some of the brightest minds we’ve encountered in crypto. (That said, I still advise everybody to be extremely cautious using bridge solutions over the next few years). 

If something like Axelar proves secure and robust, it could become the ultimate meta-chain by abstracting away the complexity for developers, making dApps “portable” (thus reducing single chain dependence), and solving scalability challenges. Perhaps most beneficially, it could end the tribal battles between heavily marketed blockchains. 

Over the long-term, L1s will become replaceable commodity service providers selling blockspace on automated marketplaces, app developers won’t have to choose between chains, and most users won’t know or care what chain their dApp or assets live on. Interoperability could thus not only solve practical problems that developers and users face but create a more decentralized and less ideologically polarized blockchain ecosystem. It will be years before this vision is realized, but the implications of this evolution have barely been explored.

Note: Nothing written above should be considered investment advice, nor a recommendation to use any product. NIV is an investor in $ATOM (Cosmos Hub’s native token), Polymer, Lava, Stride, and Axelar.

- Travis Scher, co-founder of North Island Ventures

Trend: Institutional unsecured liquidity

Last year, more than $1 billion was lent to crypto market makers on DeFi lending platforms designed for corporate clients. Now that product-market fit has been proven, it is poised to grow exponentially. 

In many respects, this trend is a natural evolution. DeFi first grew thanks to platforms like MakerDAO, which offered overcollateralized lending. This product was a good fit for individual users but harder to scale. Though easier to grow, undercollateralized lending doesn’t make sense for this audience – at least, not until there’s greater adoption of digital identities and credit scores. 

Institutions, however, are equipped to deal with undercollateralized lending. Projects like Maple Finance, Clearpool, and TrueFi have taken off by offering corporations permissioned, fully KYC-compliant liquidity pools. These organizations connect crypto liquidity providers looking for high interest on stablecoins with creditworthy companies seeking transparent on-chain loans. Wintermute, Folkvang, and other crypto market makers adopted this offering early to support on-chain trading activities on the demand side and crypto venture firms and hedge funds on the supply side. The entrance of players like Jane Street and Nexus Mutual has prompted the expansion of institutional lending pools.

Notably, DeFi lending pools have fared comparatively well in recent months. While the Luna and Three Arrows Capital turmoil highlighted the opacity of the “CeFi” lending market – the term given to projects that offer DeFi-level yields in a more “centralized” wrapper – DeFi pools operated as planned and incurred limited losses. 

I am excited to see lending platforms expand outside the crypto capital market and support non-crypto businesses. One example is Yaydu, a growth finance platform for online sellers which borrows from Centrifuge, a DeFi lender. Goldfinch and Credix are also in this space, focused on emerging markets. 

- Etienne Brunet, investor

Blowfish

Almost all crypto security efforts have focused on core consensus, smart contracts, and wallets. We harden our blockchains so they cannot be easily 51%-attacked or DDoSed. We audit and test our smart contracts so they cannot be hacked and funds remain safe (though this has been harder to accomplish reliably). We use hardware wallets and keep keys offline so that user accounts are kept secure. You need only look at the recent Slope wallet vulnerability to see why these measures are necessary.

But such efforts are in vain if the interfaces used to access blockchains are opaque and vulnerable. After all, most people access decentralized applications through hosted websites and do not call smart contracts themselves programmatically. 

Today, signing a transaction is dangerous and confusing. When you try to transact via a website, your wallet prompts you to sign a hash of data — effectively a random string of numbers and letters — that’s basically impossible to verify unless you generate the transactions yourself and ensure that the website’s proposal is, in fact, one you want to approve. A malicious website can easily propose a transaction that does something different than what you believe you’re approving. Unless you’re a very sophisticated user, it’s unlikely you would notice –  after all, it looks like a random sequence of characters. This exact style of attack happened to BadgerDAO, where a malicious website tricked users into signing transactions that transferred their funds to a hacker.

Crypto cannot reach mass adoption with such inscrutable interfaces. That’s why I’m excited about services like Blowfish and Harpie, which give users the tools they need to safeguard themselves. Blowfish is a human-language transaction simulation service that takes in transaction data and spits out a simple-to-read version of what the transaction does. For example, it could summarize that the transaction you’re about to approve trades 1 ETH for 1,000 USDC. You see this in your wallet before signing, preventing you from accidentally approving a bad transaction. Harpie takes a different approach, monitoring the mempool for potentially malicious transactions originating from a user’s account and frontrunning the hostile transaction with one of their own. It then pulls funds out of the user's account into a new, isolated one.

Overall, I’m excited about significantly reducing the viability of user and application-level attacks by giving people the transparency and tools they need to keep themselves safe.

- Tom Schmidt, partner at Dragonfly Capital

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Maple Finance

Maple Finance is the largest institutional lending marketplace on Ethereum and Solana. To date, it has facilitated approximately $1.5 billion in loans to leading crypto trading firms and market makers like Alameda Research, Wintermute, Amber Group, and others.

As seen from the Three Arrows Capital contagion and fallout, institutional lending and capital markets are opaque, inefficient, and rife with conflicts of interest. Lenders supply capital with little to no transparency around who the borrowers are, the level of counterparty concentration, and how yields are generated. Celsius has been the most egregious case of this. The firm has been functionally insolvent for a long time (without lenders knowing) and effectively gambled with customer funds.

At its core, blockchain and crypto solve for coordination and incentive alignment. Maple provides a transparent on-chain process to facilitate institutional loans. Lenders supply capital into various lending pools run by delegates – experienced underwriters who bring expertise and post collateral to align incentives and buffer first loss reserve. Each loan includes public information on the borrower’s name, loan amount, issuance date, interest rate, and collateralization ratio. Each pool provides public data on historical performance, credit losses, and borrower exposure for lenders to make informed decisions. This transparency leads to more accountability and better underwriting. While CeFi counterparts like Genesis, BlockFi, and Celsius have taken large losses in 2022, Maple loan pools have proved resilient and taken less than a 1% loss on cumulative loans issued.

Over the next decade, crypto rails will modernize existing financial infrastructure. This has already begun with stablecoin adoption, displacing legacy banking, wires, and payments. Institutional capital markets and lending are the next frontier and among the largest untapped opportunities. Crypto lending is more than a $100 billion market, and traditional corporate lending is $100 trillion. Maple is well positioned to tackle it.

- James Ho, co-founder of Modular Capital

Cosmos SDK

There are two extreme views of how crypto will end up. The first is that all activity will converge onto a single general purpose execution environment – the “monolithic” or “world computer” view. The second is that there will be many specialized execution environments, each with its designs and tradeoffs – the “multi-chain” view. The critical tradeoff is between synchronous composability, provided by monoliths, and specialization. I believe projects will increasingly opt for specialization, with the Cosmos SDK offering the best toolset for deploying app-specific chains. 

As I see it, specialization has two main benefits: lower and more predictable resource costs and customizability. Concerning the former, projects on monolithic chains compete for blockspace with all other dApps. This means they necessarily face uncertainty regarding resource costs, with something like a popular NFT mint potentially rendering their dApp unusable. In the long term, this is untenable for many dApps (e.g., games). Concerning the latter, projects launching on a monolithic blockchain inherit and must accept a series of design decisions, including the platform’s consensus model, security, runtime, virtual machine, and so on. In contrast, an application deploying its own chain (or choosing between existing specialized app chains) can customize its stack's components to optimize for its use case. We’ve already seen many great examples of this with Osmosis’s MEV resistance, dYdX’s mempool order book, L1 oracles/bridges provided by Injective, and many others.

The disadvantages of specialization are the cost of deployment and lack of synchronous composability. On cost, while a specialized chain will never be as easy to deploy as smart contracts on an existing chain, I believe the gap has narrowed significantly and is likely to continue to narrow over time as the Cosmos SDK matures and Interchain Security comes online. The latter allows Cosmos Hub to share security with other blockchains. 

The fundamental tradeoff then is synchronous composability. There are two main counter-points to this. Firstly, there are arguably only a few kinds of applications that truly benefit from this. These are mainly DeFi use cases for which rehypothecation of tokens is crucial (e.g., yield farming). For most other dApps, I would argue asynchronous composability is fine as long as there’s strong cross-chain tooling to port assets over and make the UX of interacting with different dApps seamless. Secondly, specialization doesn’t necessarily mean deploying a chain with a single application but can mean a cluster of applications synergizing well together or facilitating a particular use case. For instance, while Osmosis is often seen as an Automated Market Maker (AMM) chain, it is evolving to become a DeFi chain with different dApps deployed on it, including money markets, stablecoins, and vaults. We believe applications that benefit from composability will naturally tend to cluster around specialized chains, effectively allowing for “opt-in” composability for dApps that require it. 

For these reasons, I expect the space will evolve into a mesh network of interconnected specialized chains organized into clusters around specific use cases. DYdX was the first high-profile example, but over the next twelve months, I believe we will see a proliferation of dApps moving to specialized chains leveraging the Cosmos SDK.

- Jose Maria Macedo, partner at Delphi Digital

Space and Time

Space and Time is a blockchain-secured, decentralized, enterprise-scale database and analytics platform. It offers high-performance and tamperproof SQL analytics and machine learning on massive streaming datasets. 

Space and Time's novel Proof-of-SQL protocol uses zero-knowledge proofs (zk-proofs) to allow applications to generate analytical insights in a decentralized, low-cost, and tamper-proof way. We believe that Space and Time will be a core layer of the Web3 stack, comparable to a decentralized Snowflake.

- Tim Khoury, investor at Digital Currency Group

Trend: Web3 social networks

Social networks have profoundly impacted society over the last few decades, affecting culture, information flows, relationships, and work. It has spawned novel methods of communication and entirely new careers. With web3, we believe they have an opportunity to go a step further, unlocking net-new consumer experiences and aligning user and developer interests with those of platforms.

The open social stack – social networks built on permissionless protocols – is nascent. But at scale, an open social stack will enable various benefits related to user and developer freedom and agency: portability of data to other applications, composability of experiences and content, and the ability to introduce token incentives. Early web2 social networks shuttered competing interfaces and apps leveraging their data (e.g., TweetDeck). Conversely, open social graphs lower the barrier to entry for third-party developers to build novel experiences and customized interfaces, ultimately translating into a broader range of user choices. 

The advantages aren’t just philosophical. Users will benefit from decentralized social networks that provide new experiences that are more entertaining or useful. For example, a web3 social network offering token incentives could grant financial benefits for various activities, such as predicting which pieces of content will take off. Web3 social networks like Mirror help creators monetize their work through NFTs and community fundraising. Many social networks have succeeded as compelling experiences to showcase users’ taste and curation (e.g., Tumblr and Instagram). A web3 counterpart could allow users to express their taste with real skin in the game, showcasing digital assets they own. OnCyber and Context offer this feature already. 

New content formats – images, memes, videos, words – have been the basis of new social networks and platforms. Companies like Foundation, Sound, Catalog, and others are emergent examples of what social platforms built around NFTs can look like. 

Building a web3 social network isn’t without its challenges. Scaling remains an issue, but data layers like Ceramic provide the foundation for new social applications. The continued growth of protocols like XMTP enables wallet-to-wallet messaging, which will unlock on-chain communication. Open social algorithms also present an opportunity to create marketplaces around functions that centralized platforms currently unilaterally control, such as content moderation and fact-checking. 

Crypto is inherently financial: everything built atop crypto networks has underlying value. But it is also inherently social. It is networked, involving contributors and participants on a global scale. In the coming years, we expect growth across social infrastructure and applications that realign the interests of all stakeholders.

- Li Jin, cofounder at Variant and Mason Nystrom, partner at Variant

Railgun

Railgun is a collection of smart contracts that verify zero-knowledge proofs, enabling users to store, trade, swap, and transact privately, as well as interact with any other smart contract. Railgun supports ETH, ERC-20s, and NFTs and is live on Ethereum, Polygon, and BNB Chain. Support for Solana, Polkadot, and NEAR is coming soon.

Private transactions are essential for web3 activity to reach mass adoption. Without a solution like Railgun, a single transaction or owned NFT can dox a user, their wallet balance, and entire transaction history. DeFi transactions can also be front-run by bots, and trading strategies identified and replicated. Railgun’s solution is compliant, and read-access can be given to auditors and regulators as needed.

- Tim Khoury, investor at Digital Currency Group

Trend: The decentralized software supply chain

Building software for crypto has many challenges that require developers to rethink the traditional web2 or open source development process. While we can retain some best practices such as code review, continuous integration, unit testing, and analytics, we need to introduce new techniques due to increased security demands and the perpetual nature of decentralized applications. Web3 software is more akin to launching satellites into space than shipping a new AI photo filter. This has given rise to a sector of smart contract security tools, companies, and protocols that help facilitate this new software supply chain. In particular, we’re seeing activity around auditing, bug bounties, and static analysis and formal verification.

• Audit firms. Due to the catastrophic cost of failure in crypto systems, audit firms will continue to grow. In traditional tech, audits are a rare luxury for larger companies wanting to improve their security, but in crypto, they are an absolute necessity for projects large and small. The audit space will cover the gamut from small teams of experts specializing in consensus systems or zero-knowledge to more decentralized offerings like code4rena, which runs audit contests that attempt to crowdsource finding vulnerabilities.
• Bug bounties. While it’s normal in traditional tech to offer four-to-five figure bounties for security researchers, with some trillion dollar corporations bumping this into the low seven figures, crypto bug bounties have shattered records. Immunefi, the leading web3 bug bounty platform, is pioneering this new normal with over $40 million in bug bounties paid out and another $130 million in bug bounties available for keen-eyed security experts to claim. The magnitude of these incentives creates more secure protocols and offers long-term sustainability for developers seeking careers in security.
• Static analysis and formal verification. Another area to watch is improvements in tooling throughout the software development lifecycle.  Developer frameworks such as Ape, Foundry, and Hardhat have made it easier to write unit tests and hook in tools like Slither for static analysis and Echidna for smart contract fuzzing.  Formal verification products such as Certora enable developers to ensure their contracts are sound at the specification level and find critical bugs before and after deployment. 

By using a mixture of these approaches, the software supply chain of tomorrow can continue to become more secure and battle-hardened, hopefully making the vulnerabilities of today a rare occurrence. 

- Curtis Spencer, co-founder of Electric Capital

Sudoswap

Sudoswap is a decentralized, fully on-chain NFT exchange that functions via an AMM model. Multiple, custom liquidity pools for the same collection can be set up, each with pricing determined by its bonding curve. Sudoswap enables instant liquidity, tighter spreads, cheaper pricing, no royalty fees, trading fee earnings, and automatic dollar cost averaging in and out of collections.

NFTs are containers that can represent any unique asset on-chain. This applies to many assets beyond profile pictures, from financial contracts to real-world assets. Coupons, tickets, in-game items, and memberships can all be NFTs. Sudoswap’s on-chain composable protocol will improve the market microstructure for the space, reducing information asymmetries and increasing capital efficiency.

- Tim Khoury, investor at Digital Currency Group

Trend: Application mania

Over the last few years, crypto has focused on innovating at the base layer. We’ve seen L1s such as Ethereum, Solana, and Avalanche garner a large percentage of the attention and investment dedicated to the space. We have also seen most returns come from this layer, with many applications underperforming the platform on which they are built.

This should change over the coming years, as the base layer is only as valuable as the protocols and products built on top of it. As multi-chain infrastructure matures, we are also seeing applications expand their reach, launching on multiple chains and building out infrastructure to increase the availability of their products. 

These protocols' adoption and price appreciation have been held back by poor token structures, lack of regulatory clarity around tokens, and governance issues. The last of those has plagued some of the more successful applications like SushiSwap. We are seeing substantial experimentation with token structures and real attempts to convert amorphous DAO-like structures into operating entities that build in a decentralized fashion. Some names I am watching do this successfully include Aave, Convex, Frax, GMX, and Gains Network.

As sharper token structures, better regulatory clarity, and more robust governance emerge, we can expect crypto applications to gain momentum. 

- Avi Felman, Head of Digital Asset Trading at GoldenTree